Technology based products are subject to more rapid change and obsolescence, particularly as product life cycles shrink at the equipment level and business becomes more global. Legacy designs do remain after decades of production, but are no longer ‘cash cows’ due to significant price erosion. In addition, core technologies are now practiced worldwide, life cycles are shorter, and competitive advantage comes more from cost leadership than through customer service. Customers are looking for suppliers who can do more, support them globally, and provide error-free products at a competitive price.
As a result of these and other factors effecting industry today such as deregulation, capital market intervention and developments in technology, many small businesses and large corporations are undergoing a process of transformation. Corporations are being forced to adapt quickly to survive, and managers are finding it increasingly difficult to decide which of a staggering array of options could strategically create the greatest value for their businesses.
In an effort to cope with these changes, companies are developing an internal operating system or framework that helps them make these strategic decisions effectively and enhance their capacity to think strategically and long term, develop sound business strategy, and effectively communicate that strategy to all of the participants involved in the value creation process.
Many private company managers have also come to the conclusion that it’s a timely and prudent business strategy to look at being acquired by a larger, properly capitalized strategic partner in order to remain competitive in this type of economic environment. This new strategic alliance could come from a business that’s publicly traded, or a privately held competitor with greater access to equity or debt capital, one that possesses enhanced advertising and marketing capabilities, and has capital intensive and expansive product engineering, sales and support capabilities. A strategic partner with these attributes could provide the seller with the opportunity to achieve significant top line sales growth, which in turn should provide bottom line profits for the acquiring company. Once acquired, the seller could continue to be involved in this highly profitable, vertically oriented niche business, and at the same time, be gracefully developing an exit strategy for the company’s shareholders.
Corporations, large and small, engaged in nearly $46 million dollars of M&A activity in July of 2003 alone. Through the first half of 2003, 6,803 merger proposals – friendly and unfriendly – have been announced worth a total of $367.3 billion.
Many of these mergers and acquisitions are being done primarily because corporate America needs to achieve immediate revenue enhancement with the perception of a reduction in operating costs. Properly structured, acquisitions can actually help a company increase its cash flows, net earnings and revenues. For industries in which mergers are used less frequently, acquisitions are made strictly for reasons of cost savings and by the need to create a critical mass operating environment for the acquiring company. Companies dependent upon technology make acquisitions in response to new technologies arriving into the marketplace and to enlarge distribution networks.
The following information is a brief description of the transaction process and some of the actual components of a successful transaction.
The Transaction Process
Acquisition Structure: Sometimes the buyer’s management team is knowledgeable and experienced with the acquisition process, and therefore works directly with the seller, providing them with the appropriate purchase documents, which would initially include a preliminary term sheet. Sometimes both groups need to rely on outside consultants to properly structure and close a deal, which always incorporates a combination of cash, debt and equity as the three main components of the transaction.
Depending upon the buyer’s and seller’s agreements, the exact percentages used from each of these resources would be determined very early in the transaction process. A seller’s preference is usually to be acquired in a cash or tax-free stock exchange. An all-cash transaction is extremely unusual and only occurs in situations in which all of the sellers are exiting the business at the close of the deal. Most deals include an equal percentage of all of these transaction components.
Just about every transaction begins with the valuation process: The valuation process is one of the first and most important steps taken in the process of acquiring a business. Typically, a professional business sales and acquisition specialist will work with the seller to uncover and evaluate all of the assets of a business which would be included in the sale. This review will most likely provide the assistance the seller needs to develop a strategy that “repositions” the business for its eventual sale.
By making sure that the financial statements are in order, the inventory numbers are close to accurate, and the plant and equipment are clean and operating, the business consultant helps put the business in the best light. The “positioning strategy” is obviously designed to make the seller look more attractive to a potential acquirer. The consultant and seller hope that this strategy will ensure them of an accurate, justifiable selling price for the business and help both the seller and buyer understand exactly what is for sale. It is during this initial valuation process that the seller will determine an approximate selling price for the business.
During this evaluation process the consultant and seller will typically create and eventually submit to the buyer a booklet called a “Confidential Memorandum.” With an aggressive ongoing acquisition program, a buyer could have multiple Confidential Memorandums under review at one time. Some of the information contained in the Confidential Memorandum will include profit/loss history, sales history, competition factors, description of facilities, customer/client definition, management review, marketing information and a list of suppliers.
Buyer Qualification: In all fairness to the seller, similar information should be available from the buyer during the initial acquisition discussion process. A buyer’s disclosure of their professional financial information insures their real interest in purchasing this type of business and also addresses the issue of the buyer’s financial ability to complete the transaction.
Negotiating Process: After the buyer and seller have reviewed each other’s Confidential Memorandums, a face-to-face meeting between the parties is usually arranged. It is at this time that more in-depth discussions about the potential purchase of the business take place. A successful buyer/seller introduction, dependent on the outcome, would be followed by a more in-depth due diligence on the buyer’s part.
Letter of Intent: After the initial due-diligence process has been completed, the buyer will most likely submit a Letter of Intent (LOI) to the seller. This document sets forth much of the same information covered in a Purchase Contract, only in much less detail. It outlines the means by which the buyer would like to purchase the business and provides an opening for further discussion.
The LOI describes the principle aspects of the deal including a breakdown of the price and terms, an indication as to whether this is a stock or asset sale (see Addendum One to this section), and a general outline of how a buyer anticipates the transaction will take place. Two binding provisions of the Letter of Intent are:
· The seller shall not sell the business to anyone else during negotiations with this buyer, and · If the sale should not go through, the buyer will not disclose any information about the seller to outsiders.
Unlike a contract, an LOI is non-binding. So when the seller, in writing, has agreed to the terms and conditions of the LOI, the buyer’s attorney will then move forward with the creation of a preliminary purchase contract. The seller typically has 72 hours in which to review the buyer’s contract and either accept, reject or make a counter offer. Any changes to the contract are first agreed to in discussions between the parties prior to their inclusion into a new contract.
Contract Offer: Business acquisition transactions use a purchase contract. The contract includes all of the details for the purchase of the business. Contacts for the purchase of a business are detailed and lengthy. Extra clauses, not typical to a standard purchase contract, are added to cover the unique aspects of each particular sale. Every asset for sale, every presentation made by either the buyer or the seller, as well as the allocation or payment structure for the businesses are covered in detail in the contract. When a contact is presented to the seller, it could be accompanied by an earnest money deposit or a Break-Up fee. The amount of the earnest money deposit can be any amount but is usually equal to approximately 5% of the total purchase price. Earnest money deposits should be in the form of a bank draft or certified check and should be held by an escrow agent or mutually agreed upon attorney for the project.
Escrow: When the contract is signed by both the buyer and seller, the closing attorney or escrow agent will be contacted and instructed to open an escrow account. Should something happen to void the sale, escrow monies are distributed according the contract language.
The closing attorney will proceed to create a closing document before the sale is completed. Once this contract is signed by both parties, a closing date can be scheduled, usually within two weeks. At closing, all checks are handled, deposits are covered, commissions are paid, prorated items, such as taxes and rents, are paid or monies are escrowed to cover those expenses at a later date. Finally, bills of sale should be prepared and promissory notes executed, if appropriate. This will typically be the end of the transaction process except for one last detail.
Consulting/Management Agreements: Any employment agreements, which have been established whereby the seller is to remain in a management capacity for a specified period of time or is to be retained as a consultant to the buyer, should be executed at this time.
TYPES OF SALES
ASSET SALE : In business sales and acquisitions, there are two types of sales: Asset Sales and Corporate or Stock Sales. When selling a sole proprietorship or a partnership, an asset sale applies. In an asset sale, the old owner of a business sells the assets of the business to the new owner. Intangible assets, such as goodwill, customer lists, excess earning power, and the like, as well as tangible assets, such as equipment, inventory and other hard assets, are valued and sold.
Cash, receivables, and liabilities are not generally included as part of an asset sale. The buyer steps into the business with a clean slate. There are no hidden liabilities, no debts other than those the new owner generates. In an asset sale, it is possible to attempt to structure the sale most beneficially to both buyer and seller for tax purposes, as well. The buyer can set up a new round of depreciation on depreciable assets and can amortize any Non-Compete Agreement included in the sale. The seller can design a payout schedule to avoid a large tax on recapture.
In an asset sale, the buyer and seller choose which assets will be sold. Goodwill, business grade name and other intangibles (like the Non-Compete Agreement) can be included, as well as all tangible assets necessary to the business, such as furniture, fixtures and equipment. Bulk Sales Transfer laws (discussed in Addendum Two) apply and must be either complied with or waived by the parties.
As asset sale limits liability to a new owner since the new owner only purchases other on-going enterprise value, and it is not usually subject to undisclosed liabilities previously incurred by the previous owner. Many buyers prefer to purchase the assets of a business instead of the stock.
CORPORATE SALE: A corporation can be sold in two fashions. The first is a stock sale, in which the current shareholders of the corporation sell the existing entity in total. The other is an asset sale, whereby the corporation sells its producing assets but not corporate stock.
In a Corporate Asset sale, the assets for sale are selected in much the same way as in a regular Asset sale. Goodwill, business trade name and other intangibles can be included, along with the standard hard assets (inventory, equipment, etc.). Bulk Sales Transfer laws apply.
In many respects, a stock sale is much simpler than an asset sale. A stock sale does not have to comply with Bulk Sales laws. It keeps existing contracts in place, maintains supplier relationships and other ongoing operational considerations.
In a stock sale, however, all of the corporation’s liabilities transfer with the sale, whether they are disclosed or not. The business is purchased “as is” without loss of existing contracts or clients but with some liability risks. If a Corporate sale is the best option when buying a business, buyers should seek professional advice to insure that they are protected as much as possible from undisclosed liabilities, litigation and so forth.
U.C.C. BULK TRANSFER ACT (C.R.S. 4-0-209): The Bulk Sales Transfer Act is designed to protect a company’s creditors by assuring that they are notified before the assets of a company are sold to keep sellers from defaulting on debts that may be secured by the company’s assets.
There are significant ramifications of this law, but, most important to remember, if the Act is not complied with and if, in fact, there are undisclosed creditors, those creditors could seek payment from a new owner or an enterprise even through the new owner was unaware of the previous owner’s debts. Creditors who are not notified of a company’s sale are given six months from the date they learn of the sale to demand payment for past debts.
There are two ways to handle the Bulk Sales requirements. The Act can be complied with or waived at the discretion of the buyer and seller.
To comply with the Bulk Sales Act, all creditors who might have a claim against the company must be informed that the business is going to be sold. Creditors have ten days following notification to inform the buyer and seller of any outstanding debts. Typically, those debts are then paid prior to closing to insure that the company is “free and clear” of debt for the new owner. Creditors may also use that ten-day notification period to protest the sale.
Compliance with the Act is time consuming. What’s more, compliance eliminates the confidentiality of the sale by making the transaction public information. If, for any reason, the intended transaction does not occur, obviously “the cat is out of the bag.” All of the company’s creditors know the business was for sale. This could damage a business owner’s standing with creditors.
Compliance with the Bulk Sales Act is intended to reduce the potential of a purchaser being subject to a previous owner’s creditor claims. Unfortunately, however, that protection is dependent of the willingness of the seller to disclose the names of all creditors for notification. The names of creditors can “slip by” and leave the buyer exposed to difficult future creditor problems.
To eliminate the time and concern generated by compliance with the Bulk Sales Transfer Act, the buyer and seller may elect to waive the Act. This is oftentimes the preferred approach. In waiving the Act, the selling party usually indemnifies the purchasing party for any undisclosed liabilities and grants the purchaser a right of offset against any funds owed by the seller should any undisclosed liabilities arise after the transaction is consummated. Indemnification means the seller agrees to reimburse any expense of undisclosed past debts to the new owner, and a right of offset means that the buyer may deduct any undisclosed past debts from amounts owed the seller on promissory notes.
Should a previously undisclosed debt come to light after the sale is closed, the seller would make arrangements to have the buyer pay the debt and then deduct that amount from the next month’s debt service payments on the business. If the seller is not carrying a purchase money note, usually a professional will recommend holding a portion of the purchase money in escrow to insure against any undisclosed liability.
If monies have not been escrowed at closing to cover any undisclosed debts, the seller would most probably simply pay the debt.
Although its not the definitive study on the process of buying or selling a business, this information should give at least a brief glimpse into the process.